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Sovereign green bonds (SGBs) are the next big thing on the agenda that was unveiled as part of this year’s Union budget announcements. The Reserve Bank of India (RBI) has already begun pilot trials of a central bank digital currency (CBDC), and an SGB programme will be introduced soon, as the government has indicated. The concept of a SGB is quite rudimentary. Money raised via these by the government, expected to be 16,000 crore this year, would be deployed for green projects.

Arguably, the same goal can be achieved even without calling it a ‘sovereign green bond’ by just allocating resources for green projects with the same outlay. These green projects have to necessarily be part of the capital expenditure from allocations made to various ministries. A critic may just say that there is too much ado about what could have been a simple transaction.

The interesting part is the pricing of such bonds and the regulatory structures that could make them attractive for investors. This is important because if such a bond is to be marketed as a special government security (G-sec), then it will need enough buyers.

The first question is whether the rate of interest paid will be higher than what’s paid on a regular G-sec. It is believed an SGB will have a lower yield, in which case, there is no reason for banks holding G-secs in excess of their statutory liquidity ratio (SLR) mandate to opt for a lower-yield bond. Ideally, the interest rate should be higher, as green projects tend to be more expensive.

Also, the government may have to offer some tax concession. Here too, it is open and quite possible that there will be no benefit bestowed on them. If this is so, then banks may like to skip these auctions. As RBI has been trying to get retail investors into the G-sec market, giving tax benefits will make even lower yield bonds attractive. RBI may have to be kept in the loop to create a more friendly investment framework so that banks are enthused. Therefore, the pricing of the bond would be the most vital element of the exercise that must be worked out.

The other area of interest is the deployment of these funds. As they have to be earmarked for green projects, relevant ministries like for roads, railways, defence, communication, etc, will have to look at capital expenditure with clear commitments to green processes. But who will monitor these projects? If the money were to be deployed in, say, a solar project, then it would classify as a green venture. But then, the government does not build solar plants. Money is contracted for the construction of roads or manufacture of railway tracks, coaches and so on. This will mean having in place a thorough and credible rating system for projects to qualify as ‘green’.

Currently, we do not have such systems in place. Construction is considered one of the most anti-green activities, as it usually involves wiping off farm land to build structures that are needed for economic progress but affect the environment. Therefore, much like the concept of net-zero, all such ventures should also have plans in place whereby they generate enough environment-supporting activities. Intuitively, this is a highly complex exercise.

India has had cases of green bonds issued by banks which used the money to fund green projects. Here, it was simpler since the final product was classified as green. But when it comes to government spending, it would be a bit more complicated. Hence, before the launch of green bonds, the Centre would need to rope in rating agencies like Care, Crisil, Icra, etc, and brief them on what would be defined as green. This would set the contours of a rating model devised by these agencies that are conceptually acceptable to the government.

The big challenge will, however, lie in monitoring the progress of green projects. Normally, there are cost overruns, which can upset the budget math. This can lead to compromises. For example, the railways may source power only from a renewable source as it’s part of a green mandate, but a chance may arise of its substitution with conventional energy at some point just to stay within budgetary limits.

It is necessary, therefore, that the government works out all these details before floating green bonds. This would mean that the concept of green projects has to be objectively defined, with rating agencies brought in to lend fund deployment credibility. The budgetary puzzle is that money is fungible; what is raised from any source can be deployed anywhere. Therefore, what’s green can be open to interpretation.

The introduction of SGBs can be looked at from two points of view. The first is that it will lead to the evolution of systems for objectively grading or rating projects from an environmental perspective. Presently, most companies pay only lip service to ESG in annual reports that talk about the initiatives they have taken. As the rating system evolves, it could directly engage the project appraisal processes of all credit proposals. This will raise consciousness on promoting green approaches. We are already witness to how climate damage has changed almost everything in the world. Our monsoon pattern has got distorted, for example, which has led to crop damage. Cities like Gurugram and Bengaluru have suffered severe waterlogging, mainly due to faulty road planning, where the fault ultimately points to government authorities. The environment is thus also a direct concern of governments and the launch of SGBs would be a big move.

These are the author’s personal views.

Madan Sabnavis is chief economist, Bank of Baroda, and author of ‘Lockdown or Economic Destruction?’

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